Update from Martin Scammell: VAT early termination fees and compensation payments

Update 10/8/21

HMRC have circulated a draft of its revised guidance on VAT on early termination fees and similar payments.  The draft can be found here.   Martin Scammell has received clearance from JVCC for HMRC's revised guidance to be shared for comment but HMRC have said that "this is our proposed line and is not necessarily our final word on the matter."  HMRC has requested that comments are sent to them by the end of August.  Please contact Andrea if you have any comments and she will forward them via the JVCC.

The draft guidance advises that although HMRC took the view that payments described as compensation were typically outside the scope of VAT, recent case law indicates that payments described as compensation or damages can be consideration for supplies and therefore potentailly subject to VAT.  For there to be a supply, there needs to be reciprocity between the supplier and the customer, and a direct link between the consideration and the supply.

Dilapidation payments

The draft guidance says that "Our policy having weighed these factors is not to treat dilapidation payments as further consideration for the supply of a lease. We might depart from that view if in individual cases we found evidence of value shifting from rent to dilapidation payment to avoid accounting for VAT."

Early termination payments

The draft guidance sets out that, "HMRC’s policy is to treat payments arising out of early contract termination as further consideration for the supply where the payments are linked to that supply, which will normally be the case. Businesses must account for VAT on these fees if the supply is taxable. This applies in cases where the original contract allows for such a termination, as well as when a separate agreement is reached."

Liquidated Damages and Breach of Contract

Under the draft guidance, therse are regarded as consideration for supplies.

What next?

Assuming that this draft (or something very similar to it) is adopted, it is important that members carefully consider the impact of VAT on compensation payments.  The draft guidance appears to suggest that in a number of scenarios, HMRC will take the approach that a supply has been made.  Members may wish to consider: 

• is there a supply that a "compensation" payment can be linked to?
• if yes, what is the VAT liability of the supply?
• is the payment inclusive or exclusive of VAT? (Are there VAT clauses in the contract and what do they say; or is the contract "silent" on VAT?)
• if receiving the payment, what is the impact on VAT recovery on costs associated with the supply?
• if making the payment and VAT is charged, is any element of the VAT recoverable?
• if there is no supply, do you have adequate evidence to support "outside the scope" treatment?

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Message from Martin Scammell dated 12 October 2020.

Thanks to Martin for this update.

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This is to everyone who has asked me to keep them updated on RCB 12/20, about early termination and compensation.  Please accept my apologies if the below is not news.

Discussions with HMRC are ongoing.  They met with a sub-group of the JVCC yesterday, and the meeting focussed on retrospection, reliance on guidance, taxpayer goodwill etc.  HMRC said that Counsel had advised that taxpayers did not have a legitimate expectation based on the previous guidance, but they have confirmed that they are considering the points that we raised, and have promised a further meeting.

In the meantime, rumours have been circulating that HMRC have concluded that dilapidations are consideration for a supply, and that there is a potential exposure for the last four years.  This is not the case:  they are still looking at this, and at other payments in connection with leases.  The misunderstanding seems to have arisen in the course of one or more conversations that HMRC officers have been having with some of the accountancy firms, but their staff have today been advised not to take proactive action on the basis of the RCB while its implications are being considered.